One of this year’s most controversial business and political topics is outsourcing to low-cost labor markets. At a recent CFO magazine conference in New York, we learned how companies are framing this complex decision—with a look at the long-term risks as

Risks and rewards: one of this year’s most controversial business and political topics is outsourcing to low-cost labor markets. At a recent CFO magazine conference in New York, we learned how companies are framing this complex decision—with a look at the long-term risks as well as the rewards. Here’s a summary

Moderate economic growth and high expectations from Wall Street have placed continued pressure on companies to reduce costs. Against this tense economic background, outsourcing knowledge-worker jobs to a tech-savvy, highly skilled workforce overseas is a compelling opportunity for companies seeking to achieve substantial cost reductions. Its appeal has only been heightened by recent advances in IT and telecommunications–advances that have extended U.S. companies’ global reach and made offshoring more practical than ever.

More and more companies are considering whether–and how–to outsource pieces of their business. To accomplish this successfully, they must find solutions that effectively balance the risks and the rewards of outsourcing.

THE RISKS–AND THE REWARDS–OF OUTSOURCING

In general, companies outsource activities to take advantage of:

* Labor cost arbitrage

* Business process improvement

* Economies of scale

* Improved access to innovative technologies

Outsourcing helps companies to deploy resources more flexibly, allowing them to divest or acquire capabilities with relative ease. And businesses are now exploring outsourcing as a means to achieve strategic goals, such as expanding into new markets or opening fresh distribution channels. But offshore outsourcing also carries significant risks for complex businesses, including political risks and the business risks that accompany surrendering control of business processes.

The political backlash against outsourcing has received a great deal of attention in this election year. As former U.S. Secretary of Labor Robert Reich explained to conference attendees, “The underlying fear of globalization comes from a deep-seated insecurity.”

But the backlash against outsourcing, he suggested, may be unfounded: “Every business is turning into a global network, and our standard of living depends on the value added to that network.” The challenge to Americans, according to Reich, is how to add maximum value to an already global economy.

Indeed, a real-time survey of conference attendees (sponsored by Capgemini) revealed that political risks aren’t prominent concerns for many senior finance executives. Eighty-eight percent of senior finance executives surveyed said that the U.S. political and regulatory debate over offshoring had only a minor impact–or no impact at all–on their companies’ interest in outsourcing offshore. It seems that the media commotion surrounding the political debate masks senior finance executives’ real concern: managing the business risks of offshore outsourcing to maximize success.

These business risks can seem daunting to many companies considering outsourcing, even in light of potential gains. Common concerns include:

* Security of customer data and intellectual property

* Integrity of core business processes

* Ambiguity in performance metrics

* Potential for “cost creep” over the long term

* Weakness in a vendor’s internal management

* Efficiency of vendor processes

The risk of outsourcing business processes is heightened by the difficulty of bringing outsourced activities back in-house. Conference speakers proposed strategies to mitigate these risks and capture the value of offshore outsourcing.

SOLUTIONS–BALANCING RISK AND REWARD

According to conference speakers, companies can mitigate the risks of outsourcing by employing these strategies for success:

Choose the right processes to outsource. Rather than focusing exclusively on cost, narrow the list of outsourcing possibilities with these questions in mind:

* Which activities are core–and which are not core–to the business model?

* Which activities can be performed more productively elsewhere?

* Which activities benefit from proximity to customers?

* Which activities would benefit from external process management expertise?

Companies can also get the most out of outsourcing by seizing the opportunity to refine and recast their business processes–and thereby outsource the most effective process possible.

Analyze risk rigorously. Select processes for outsourcing based on careful, rational risk analysis. Tom Davenport, professor of management and information technology at Babson College, offered conference attendees a risk analysis method based on the process management discipline (see sidebar, “How should companies manage outsourcing risk?”).

Choose the right partner. Look beyond the cost of services when choosing outsourcing partners. The best partners are characterized by flexibility, expertise, and access to technology, as well as a competitive cost structure in every phase of the relationship–including the transition phase, service delivery phase, and termination phase.

Create a solid governance structure. Presenters at the conference agreed that solid governance is essential to the success of an outsourcing relationship. “I’ve gained tremendous experience through my occasional failures in offshore outsourcing,” said conference panelist Jag Dalai, founder of JDalal Associates. “The most common factor in all [failures] was the lack of governance in setting up processes, relationships, and communication.”

Features of a solidly governed outsourcing partnership include:

* Built-in incentives for vendors who meet productivity targets

* Stringent enforcement provisions, including self-executing remedies

* Explicit provisions for securing customer data and intellectual property

* Meaningful performance metrics

* Flexible termination strategies

Communicate clearly. Offshore outsourcing relationships cross more than national borders and time zones–they cross cultures. Clear communication is a necessity that cuts across all aspects of the outsourcing relationship, from specifying the work to be done, to defining performance metrics, to setting incentives for productivity, to terminating the relationship painlessly. Paying attention to cultural and linguistic differences–and keeping the lines of communication open–is a significant part of a partnerships success.

For your free copy of the full conference conclusions paper, entitled Offshore Outsourcing–Risks and Rewards, please visit www.cfo-research.com.

A special thanks to our sponsors who made the conference possible: Corporate Sponsors

How should companies manage outsourcing risk?

In the opening session, Tom Davenport, professor of management and information technology at Babson College, explained that companies often make outsourcing decisions using a short-term, crisis approach which focuses too closely on cutting costs. A more sophisticated approach, he said, calls for a rational assessment of outsourcing as a strategic opportunity, rather than as a short-term, stopgap measure.

After making an initial assessment of outsourcing candidates, Davenport said, companies should use process management tools to evaluate a process for outsourcing according to the type of knowledge and the degree of structure inherent in that process.

Knowledge. The knowledge dimension of a business process can be defined as either tacit or explicit. Tacit knowledge is based largely on experience, iteration, and deep expertise. It is especially important, Davenport noted, in the realm of personal relationships: “We talk about global relationships, and indeed, we are moving into them, but there’s something about us that likes to see the whites of the eyes whenever we can.” Explicit knowledge, on the other hand, is less personal and can be easily codified and documented.

Structure. Davenport defined highly structured processes as highly repeatable, transaction-oriented processes than can be easily replicated and are often not core to a business. Less-structured processes tend to be more variable, creative, and strategic.

By placing processes in a knowledge-structure matrix, as shown in Figure 1, companies can evaluate the risk of outsourcing a given process.

[FIGURE 1 OMITTED]

Processes located in the upper right of the matrix–such as transaction processing or inbound sales–are lower-risk processes and, therefore, more likely outsourcing candidates. Processes located in the lower left are higher risk, more core to the business, and often best kept in-house. “If it’s innovation,” said Davenport, “if it’s highly profitable, we’ll keep it. If it’s not, we’re not going to keep it.”

COPYRIGHT 2004 CFO Publishing Corp.

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